Regulation of NBFCs Historical Evolution 1. February 01, 1964 ? ? Chapter III B was inserted in the Reserve Bank of India Act, 1934 Gave only limited powers to Reserve Bank i.e. on regulation of deposit acceptance by NBFCs.
2. 1974 - Chapter V (on Penalties) was inserted in RBI Act, 1934. 3. February 15, 1984 - Chapter lll C (to regulate deposit taking activities of UIBs) was inserted in RBI Act, 1934. 4. 1992 - Working Group on Financial Companies by RBI (Chairman: Dr. A.C. Shah). Reserve Bank of India Act, 1934, did not confer RBI with adequate powers to make the recommendations mandatory. 5. April 1993 – System of registration for NBFCs with NoF Rs. 50 lakh and above was introduced. 6. June 1994- RBI prescribed prudential norms as an attempt to regulate the assets of the companies. 7. 1995 ? ? Khanna Committee (Expert Group on Designing a Supervisory framework for NBFCs) .Recommendations laid foundation to the supervisory framework of NBFCs. The supervision of the NBFC sector was brought under the jurisdiction of the Board for Financial Supervision (BFS) (July 01).
8. 1997 - Department of Non-Banking Supervision (DNBS), was formed by segregating FCW from DoS, for focused attention to the supervision of NBFCs by 16 Regional Offices. 9. March 1997 - the Reserve Bank of India (Amendment) Act was passed amending Chapter lll B, lll C and V of RBI Act, 1934. 10. April 30, 1997 - Reserve Bank of India (Non-Banking Financial Companies) Returns Specifications 1997 was issued. 11. January 02, 1998 - New Regulatory Framework for NBFCs ? NBFCs were classified into 3 categories for purposes of regulation, viz, (i) those accepting public deposits; (ii) those which do not accept public deposits but are engaged in the financial business, and (iii) core investment companies which hold at least 90 per cent of their assets as investments in the securities of their group/holding/subsidiary companies. New entry point norm of Rs. 25 lakh. While NBFCs accepting public deposits were to be subjected to the entire gamut of regulations, those not accepting public deposits would be regulated in a limited manner. In respect of new NBFCs (which are incorporated on or after April 20, 1999 and which seek registration with the Reserve Bank), the minimum NOF was raised to Rs. 2 crore.
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12. January 31, 1998 - Directions were issued as under: ? ? Non-Banking Financial Companies Acceptance of Public Deposits (Reserve Bank) Directions, 1998 Non-Banking Financial Companies Prudential Norms (Reserve Bank) Directions, 1998
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Non-Banking Financial Companies Auditor’s Report (Reserve Bank) Directions, 1998.
13. August 1998- Task Force on Non-Banking Finance Companies under the Chairmanship of Shri C M Vasudev, Special Secretary (Banking), Ministry of Finance to examine the adequacy of then legislative framework was set up. 14. October 1998 - The Task Force submitted its Report to the Government. Recommendations included: ? ? ? higher CRAR for NBFCs than banks, statutory powers to RBI to appoint depositors' grievance redressal authorities, review of prudential norms etc.
15. April 08, 1999 – Press Release issued by RBI defining principal business. A company will be treated as an NBFC ? ? ? if its financial assets are more than 50 per cent of total assets (netted off against intangible assets) and income from financial assets is more than 50 per cent of the gross income. both these criteria are required to be fulfilled as the determinant factor for principal business of a company.
16. January 13, 2000 – On the lines of scheduled commercial banks, all NBFCs having asset size of Rs. 50 crore or above were advised to have compulsory internal audit system and also constitute an Audit Committee from among the members of their Board of Directors. 17. January 13, 2000 – Exemptions were granted to NBFCs (Section 25 Companies) engaged in micro financing activities, MBCs (Potential Nidhis) and Government companies (registration applicable) from Core provisions of RBI Act, 1934 and Directions, subject to eligibility criteria. 18. June 09, 2000 - Guidelines for entry of NBFCs into insurance business was issued. 19. December 13, 2000 - Financial Companies Regulation Bill, FCRB was introduced in the Lok Sabha. The Standing Committee on Finance submitted its report in July 2003, making 21 recommendations for amendments in the FCRB. The Committee recommended that only deposit taking companies should be covered under the new legislation. 20. June 27, 2001 – The concept of asset liability management was introduced in 2001 for all NBFCs with asset base of Rs. 100 crore or holding public deposits of Rs. 20 crore or more. 21. November 28, 2002 - Venture Capital Fund Companies registered with SEBI and not holding public deposits were exempted from core provisions of RBI Act and Directions. 22. January 08, 2003 - Stock broking companies, registered with SEBI and not holding public deposit were exempted from core provisions of RBI Act and Directions. 23. March 29, 2003 - As part of implementation of the recommendation of the Working Group on Redesigning of Financial Statements of NBFCs, additional schedule to Balance Sheet of NBFCs was stipulated for all NBFCs. 24. June 18, 2003 - In terms of amended FEMA Notification No. 94 dated June 18, 2003, Foreign Direct Investments (FDI) was permitted under automatic route for 18 specified NBFC activities subject to minimum capitalisation norms.
25. 2004 - Several all India associations and State level associations formed a Self Regulatory Organisation named Finance Industry Development Council (FIDC). 26. June 2004 – Discussions were held with NBFCs regarding their plan of action for voluntarily phasing out of their acceptance of public in line with international practices. NBFCs-ND were advised that they would require Rs. 2 crore NoF before applying for permission to accept public deposits. 27. February 2005 - the Government of India (GOI) was advised by RBI that a separate legislation, viz., FCRB 2000, for financial companies was not necessary since the initiatives taken by RBI and the change in the composition of the sector, had addressed the issues to a great extent. 28. September 06, 2005 - A system of monitoring the capital market exposure of NBFCs-ND-SI through monthly returns was brought in. 29. December 2005 - The concept of Corporate Governance was introduced in 2005 with directions to rotate partners of statutory auditors after three years and further elaborated in August 2007. 30. September 28, 2006 - Guidelines on Fair Practices Code was issued to NBFCs. 31. December 06, 2006 - A new category of NBFCs formed as Asset Finance Companies by combining the classes of Equipment Leasing and Hire Purchase Companies. 32. December 12, 2006 ? ? ? ? Systemic significance of the sector was recognized and NBFCs with asset size of Rs. 100 crore and above classified as systemically important companies Capital adequacy requirements and credit concentration norms introduced. NBFCs allowed to issue co-branded credit cards with scheduled commercial banks without risk sharing and with prior approval of RBI subject to certain eligibility criteria.
33. February 22, 2007 - The need for differential regulation was recognized for deposit taking and non deposit taking companies and separate prudential norms were issued for them in February 2007. 34. April 27, 2007 - submission of an annual statement of capital funds, risk asset ratio etc., as at end of March every year in form NBS-7 was stipulated for NBFCs-ND-SI. 35. August 01, 2008 - Guidelines for NBFC-ND-SI as regards capital adequacy, liquidity and disclosure norms was issued ? ? ? Increase in Capital adequacy to 12% w.e.f March 31, 2010 and 15% w.e.f March 31, 2011 introduction of ALM reporting and disclosure norms for NBFC-ND-SI
36. September 24, 2008 – NBFCs with asset size of Rs. 50 crore and above but less than Rs. 100 crore were advised to submit online, a quarterly return on important financial parameters. 37. October 29, 2008 - NBFCs-ND-SI were permitted to issue Perpetual Debt Instruments (PDI) in accordance with the guidelines issued. 38. September 17, 2009 – Instructions on takeover / acquisition of a deposit taking NBFC, would require prior permission of RBI were issued.
39. September 18, 2009 -NBFCs were allowed to participate in Interest Rate Futures market subject to prescribed conditions. 40. February 12, 2010 - New class of NBFCs viz; IFCs introduced and eligibility criteria stipulated. 41. July 09, 2010 - Issue of guarantees by NBFCs-ND-SI treated as akin to access to public funds for considering applications for special dispensation from exposure norms. 42. August 09, 2010 – NBFCs permitted to participate in currency futures only for hedging. 43. August 11, 2010 – NBFCs-ND-SI permitted to participate in repo of corporate debt securities. 44. August 12, 2010 and January 05, 2011 – Guidelines and Notification on Core Investment Companies (CICs) issued. 45. September 16, 2010 – NBFCs permitted to participate in currency options for hedging. 46. January 17, 2011 - Provisioning requirement for standard assets - a general provision at 0.25 per cent of the outstanding standard assets introduced. 47. Feb 02, 2011 - Gold loans not to be treated as agricultural loans and the priority sector status for such bank lending was removed (RPCD circular). 48. Feb 17, 2011 - CRAR requirement of NBFCs-D raised to 15% from the extant 12% w.e.f March 31, 2012. 49. March 30, 2011 - NBFCs were prohibited from contributing capital to any partnership firm or to be partners in partnership firms. 50. May 27, 2011 - contribution made by the group entities in an insurance JV along with the NBFC brought within the ceiling of 'not more than 50% of the paid up equity capital of the insurance JV'. Group concept in this case has been revised on the lines of CICs.
Growth of nbfcs 2.5 Profile of the NBFC Sector 2.5.1 The total number of NBFCs was 12,662 as on March 31, 2010, comprising 311 deposit taking NBFCs (NBFCs-D), 295 systemically important non deposit taking companies, (NBFCs-ND-SI) and 12,056 other non-deposit taking NBFCs (NBFC-ND). 2.5.2 The number of NBFCs-D (excluding RNBCs) and the amount of deposits held by them have been showing a sharp decline over the years. Table 1 and Chart 1 below show the trend in the amount of deposits held by them as a share of bank deposits for the years 1998, 2006 and 2010.
Table 1: NBFCs@ - Acceptance of Public Deposits (Rs. Crore) Year No. of Public Public Deposits Reporting Deposits as % of Bank Companies Deposits 1997-98 1420 13572 2.27% 2005-06 428 2448 0.12% 2009-10 280 2753 0.06% @ Excluding RNBCs
2.5.3 At the same time, the NBFC-ND-SI sector, which constitutes 70 per cent of total assets of NBFCs, recorded significant growth. Their number increased from 151 in March 2006 to 295 in March 2010, and their assets grew from Rs. 250,765 crore, to Rs. 566,853 crore in the same period. Table 2 and Chart 2 give the growth of assets in the NBFC sector as a whole, (NBFC-D and NBFC-ND-SI), since 1997-98.
Table 2: NBFCs@@ - Growth of Asset (Rs. Crore) Year No. of Reporting Total CAGR Total Assets as Companies Assets (%) % of total Bank Assets 1997-98 1420 34790 4.4 2005-06 586 288593 30.3 11.1 2009-10 575 661186 23.0 11.0 @@ Excludes RNBCs but includes deposit taking (NBFCs-D) and systemically important non-deposit taking NBFCs (NBFCs-ND-SI) which account for about 90% of total assets of the sector Data for the year 1997-98 includes only deposit taking NBFCs while other two periods, 2005-06 and 2009-10 includes deposit taking NBFCs and
NBFCs-ND having assets size Rs. 100 crore & above (ND-SI)
2.5.4 Table 3 and Chart 3 indicate that bank borrowings constitute an important source of funds for NBFCs. The NBFCs-ND-SI are significant from the systemic point of view as they also access public funds indirectly through commercial papers, debentures and inter-corporate deposits apart from bank finance. Table-4 and Chart 4 give the details in this regard.
Table 3: NBFCs@@ - Borrowings from Banks as Source of Funds (Rs. Crore) Year No. of Total Bank CAGR (Bank Bank Reporting Assets Borrowings Borrowings) Borrowings as Companies % of Total Assets 1997-98 1420 34790 5554 16.0 2005-06 586 288593 54171 32.9 18.8 2009-10 575 661186 121774 22.4 18.4 @@ Excluding RNBCs but include deposit taking and non-deposit taking NBFCs which account for about 80% of total assets of the sector (Source : Returns) Note: Data for the year 1997-98 includes only deposit taking NBFCs while other two periods, 2005-06 and 2009-10 includes deposit taking NBFCs and NBFCs-ND having assets size Rs. 100 crore & above (ND-SI)
Table 4: NBFCs@@ - Sources of Funds 200910 Owned Fund 65068 161288 218454 (22.5) (24.4) (25.9) Public Deposits 2667 2753 3935 (0.9) (0.4) (0.5) Bank Borrowings 53188 120986 176879 (18.4) (18.3) (21.0) Debentures 68138 154109 186883 (23.6) (23.3) (22.2) Commercial Papers 13785 35546 33672 (4.8) (5.4) (4.0) Inter-Corporate Borrowings 19718 19898 25972 (6.8) (3.0) (3.1) Others 66029 166607 196854 (22.9) (25.2) (23.4) Total Assets 288593 661187 842649 (100.0) (100.0) (100.0) @@ Excludes RNBCs but include deposit taking (NBFCs-D) and systemically important non-deposit taking NBFCs (NBFCs-NDSI)which account for about 90% of total assets of the sector Note: Data for the year 1997-98 includes only deposit taking NBFCs while other two periods, 2005-06 and 2009-10 includes deposit Year 2005-06 (Rs. Crore) 2010-11
taking NBFCs and NBFCs-ND having assets size Rs. 100 crore & above (ND-SI) Note: Others include interest accrued, borrowings from relatives, deferred credits and other borrowings
2.5.5 Category wise profitability of NBFCs: Table 5 and Chart 5 show the growth of assets as per type of NBFCs while Table 6 and Chart 6 gives the ROE, ROA and leverage ratio for various types of NBFCs.
Table 5: Growth of Assets as per type of NBFCs (yoy %) NBFCs (Rs. Crore) Year 2006-07 2007-08 2008-09 2009-10 2010-11 Asset Finance Companies 52261 73598 97686 113951 138074 (40.8) (32.7) (16.7) (21.2) Investment Companies 119191 115677 121267 143244 153683 -(2.9) (4.8) (18.1) (7.3) Loan Companies 182351 244884 371102 403992 497580 (34.3) (51.5) (8.9) (23.2) Total Assets 353803 434159 590055 661187 789337 (22.7) (35.9) (12.1) (19.4) Figure in brackets represents percentage growth rates on year-on-year basis Note: Loan companies include infrastructure finance companies, MFIs and gold loan companies and Govt. companies Note : The above data pertains to both NBFC-D and NBFC-ND-SI
Table 6: Profitability Indicators of NBFCs, As on Mar 31, 2010 Type of NBFC Total Return on Assets Return on Equity Leverage Ratio Assets (%) (%) (%) NBFCs-D ND-SI NBFCs-D ND-SI NBFCs-D ND-SI Public Sector NBFCs 61988 2.9 1.1 22.2 11.0 13.1 10.1 IFCs 196158 NA 2.8 NA 16.3 NA 17.1 AFCs 113951 2.8 1.3 19.8 8.5 14.2 15.1 Gold Loan Companies 8650 4.6 3.9 19.4 37.4 23.9 10.5 MFIs 13675 NA 3.7 NA 21.4 NA 17.4 Other Loan & investment 266764 4.5 1.7 6.0 3.8 75.9 44.5 Companies All NBFCs 661186 3.0 2.0 19.4 7.1 15.6 28.6 Note: 1. NBFCs-D=Deposit taking NBFCs and ND-SI=non-deposit taking systemically important NBFCs (NBFCs-ND with assets size Rs. 100 crore & above) Note: 2. Leverage Ratio = Tier-I Capital as a % to Total Assets Source: Annual Returns on NBFCs-D and ND-SI
Residuary Non-Banking Companies (RNBCs) 5.18 RNBCs are a class of NBFCs which cannot be classified as equipment leasing, hire purchase, loan, investment, nidhi or chit fund companies, but which tap public savings by operating various deposit schemes, akin to recurring deposit schemes of banks. The deposit acceptance activities of these companies are governed by the provisions of Residuary Non-Banking Companies (Reserve Bank) Directions, 1987. These directions include provisions relating to the minimum (not less than 12 months) and maximum period (not exceeding 84 months) of deposits, prohibition from forfeiture of any part of the deposit or interest payable thereon, disclosure requirements in the application forms and the advertisements soliciting deposits and periodical returns and information to be furnished to the Reserve Bank.
5.19 In the absence of any linkage of deposits to their NOF, to safeguard the depositors' interests, these companies have been directed to invest not less than 80 per cent of aggregate deposit liabilities as per the investment pattern prescribed by the Reserve Bank, and to entrust these securities to a public sector bank to be withdrawn only for repayment of depositors. Subject to compliance with the investment pattern, they can invest 20 per cent of aggregate liabilities or ten times its net owned fund, whichever is lower, in a manner decided by its Board of Directors. 5.20 The RNBCs are the only class of NBFCs which are enjoined to pay a minimum rate of interest on their deposits. The floor rate of interest for deposits are specified by the Reserve Bank in terms of RNBC Directions, 1987. There is no upper limit prescribed for RNBCs unlike other NBFCs, which can pay any rate of interest subject to the maximum ceiling prescribed by the Reserve Bank. The floor interest rate payable by RNBCs was revised downwards from 6 per cent to 4 per cent per annum (to be compounded annually) on daily deposit schemes and from 8 per cent to 6 per cent per annum (to be compounded annually) on other deposit schemes of higher duration or term deposits. The provisions of prudential norms were extended to RNBCs, under the provisions of the NBFC Prudential Norms (RB) Directions, 1998 and compliance with prudential norms is mandatory and a prerequisite for acceptance of deposits. 5.21 Monitoring and inspection of these companies, from time to time, revealed continuance of many unsatisfactory features like non-compliance with the core provisions of the Directions, forfeiture of the depositors' money on one pretext or the other, diversion of depositors' money to associate concerns and/or investment in illiquid assets, violation of investment requirements/pattern, etc., thus jeopardising the interests of depositors. The Reserve Bank was issuing prohibitory orders on a case-by-case basis restraining erring RNBCs from accepting deposits. Some of the ingenious promoters floated new companies and started accepting deposits through new entities or shifted their area of operations to other States. The requirement of compulsory registration before commencing business of RNBC and concerted action taken against such companies has curbed such practices to a large extent. 5.22 The Reserve Bank received 106 applications for Certificate of Registration (CoR) from NBFCs which were functioning as RNBCs by accepting deposits under some scheme or arrangement. While 12 companies subsequently converted themselves to NBFCs, applications of 84 companies have been rejected. Ten NBFCs are still functioning as RNBCs, the total deposits of which amounted to nearly Rs. 11,000 crore, constituting about 57.0 per cent of the total deposits of all reporting NBFCs.
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the role of Non-Banking Finance Companies (NBFCs) in transferring the funds from lenders to borrowers has been well-recognized. The main advantages of these companies lie in the lower transactions costs of their operations, their quick decision-making ability, customer orientation and prompt provision of services. Partly on account of these advantages, NBFCs have in recent years grown sizeably both in terms of their numbers as well as the volume of business transactions The rapid growth of the NBFCs sector can also be attributed to other factors. NBFCs were historically subjected to a relatively lower degree of regulation vis-à-vis banks. Secondly, the higher rates of return on deposits offered by NBFCs have enabled them to attract a large base of small savers. Added to these was the fact that the operations of NBFCs were characterized by several distinctive features viz., no entry barriers, limited fixed assets and no holding of inventories-all of which led to a proliferation of NBFCs. The growing role of NBFCs was recognized by the second Narasimham Committee (1998) as well as by the Reserve Bank of India in its Discussion Paper on Harmonisation of the Role and Operations of DFIs and Banks, as also in the Report of the Working Group on Money Supply (Chairman: Dr. Y.V. Reddy)
Size of NBFCs Sector and their Growth http://www.rbi.org.in/scripts/PublicationsView.aspx?Id=13979
In line with the global trend, NBFCs in India too emerged primarily to fill in the gaps in the supply of financial services which were not generally provided by the banking sector, and also to complement the banking sector in meeting the financing requirements of the evolving economy. Over the years NBFCs have grown sizably both in terms of their numbers as well as the volume of business transactions (RBI, 2009). The number of such financial companies grew more than seven-fold from 7,063 in 1981 to 51,929 8 in 1996. Thus, the growth of NBFCs has been rapid, especially in the 1990s owing to the high degree of their orientation towards customers and simplification of loan sanction requirements (RBI, 2000). Further, the activities of NBFCs in India have undergone qualitative changes over the years through functional specialisation. NBFCs are perceived to have inherent ability and flexibility to take quicker decisions, assume greater risks, and customise their services and charges according to the needs of the clients. These features, as compared to the banks, have tremendously contributed to the proliferation of NBFCs in the eighties and nineties. Their flexible structures allowed them to unbundle services provided by banks and market the components on a competitive basis. Banks on the other hand, had all along been known for their rigid structure, especially the public sector banks. This compelled them carry out such services by establishing ‘banking subsidiaries’ in the form of NBFCs. The willingness of NBFCs to engage in varied forms of financial intermediation, hitherto unavailable to the banking system, has provided the valuable flexibility in financing new areas of business. Though the NBFCs are different species and smaller in size as a segment when compared with the banking system, their relevance to the overall economic development and to certain specified areas cannot be undermined. Over a period as the regulatory requirements were made progressively stringent, the total number of NBFCs registered with the Reserve Bank stood at 12,409 by end-March 2011. The number of NBFCs-D declined considerably with conversion into non-deposit taking companies, besides closure and mergers of weaker companies. Incidentally, the regulatory regime also seems to be in favour of reducing the number of deposit taking NBFCs and consequent migration of depositors towards the banking system which is better regulated and supervised in line with the global standards. It may be underlined that the public deposits of NBFCs, after showing a steady increase till 2007, declined thereafter and sharply by end-March 2011. However, the size of total assets, have grown more than double from Rs. 53,878 crore as at end-March 2001 to Rs. 1,16,897 crore by end-March 2011, clearly indicating greater demand for the services provided by these companies in a fast growing economy (Table 1). The net owned fund (NoF) of NBFCs has also increased sharply between end-March 2001 and end-March 2011 by more than three times to Rs. 17,975 crore, showing the strength of the NBFCs segment.
Table 1: Profile of Non-Bank Finance Companies in India (end-March) Item No of COs registered with RBI@ 875 981 573 466 362 364 336 308 297 No of reporting 981 910 companies* Total Assets* 53,878 58,290 58,071 53,878 52,900 57,453 71,171 94,744 97,408 1,12,131 1,16,897 (20,362) (17,955) (19,056) (21,891) (23,172) (24,452) (20,280) (17,919) (11,466) (Amount in Rs.crore) 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 13815 14077 13849 13764 13261 13014 12968 12809 12740 12630 12409
Public Deposits* Net Owned Fund*
18,085 18,822 20,100 18,085 20,246 22,842 24,665 24,395 21,548 17,352 11,964 (15,065) (15,327) (16,600) (20,175) (22,622) (22,358) (19,595) (14,521) (7,902) 4,943 4,383 4,950 4,943 5,510 6,663 8,601 12,261 13,458 16,424 17,975
(809) (1,002) (1,065) (1,183) (1,366) (1,718) (1,870) (2,921) (2,988) @ This includes all NBFCs (both deposit taking and non-deposit taking). * NBFCs include Deposit taking NBFCs (NBFCs-D), Mutual Benefit Financial Companies (MBFCs) (Notified Nidhis), Mutual Benefit Companies (MBCs) (Potential Nidhis) etc, till 2004-05 and only NBFCs-D thereafter. Note: Figures in brackets relates to RNBFCs. Source: Report on Trend and Progress of Banking in India various issues.
Over the years, especially with the Reserve Bank’s regulation becoming progressively more broad-based and stringent, the size of the NBFCs (in terms of numbers) as a segment has been reduced drastically as most of the unviable and substandard companies disappeared from the scene. It is also clear from the percentage share of non-banking deposits of household sector saving in gross financial assets, which decreased from around 4.0 per cent in 1997-98 to 1.8 per cent in 2008-09 (chart 1).
Further, the ratio of deposits of NBFCs to aggregate deposits of scheduled commercial banks (SCBs) showed a consistent decline revealing the regulatory focus of the Reserve Bank which emphasised on the discouragement of deposit taking NBFCs.
Thus, in comparison with the banking system in India the size of deposits in respect of NBFC-D showed a constant decline over a period and reduced to very small in size (Chart 2). Interestingly, the ratio of NBFC-D assets to banking sector since 2006 seems to have reversed from the declining trend as their asset size began swelling, though when compared with the banking system it is very small. As the size of deposits is not growing in tandem with the growth of their assets, obviously it becomes inquisitive to ascertain the source of funding the asset growth of NBFCs. In this context, analysis of sources and application of funds in respect of NBFCs-D revealed that among the sources, there is consistent increase in the borrowings and it emerged as the major source of finance to the tune of more than 72 per cent of the total liabilities at the end of March 2009. However, it slowed down to 66.7 per cent by end-March 2011. Even in the case of deposit taking NBFCs, public deposit as a share in the total liabilities have been drastically reduced to a meagre 3.85 per cent at the end-March 2011 from as high as 21 per cent in endMarch 2001, while the borrowings shot up. It is of particular significance to note that funding by banks and FIs have been on the increase to reach more than 50 per cent in the total borrowings (Table 2). On the deployment of funds, the major chunk is in the form of loans and advances and hire purchase assets together accounted for more than 73 per cent as at the end of March 2011. It needs to be underlined that they, by and large, are medium to long term assets, while major part of the funding of these assets are not of long term sources.
Table 2 : Sources and Application of Funds by the NBFCs-D (Percentage Share in the Total Assets/ Liabilities 2001 2005 2006 2007 2008 2009 2010 Sources Paid up Capital Reserves & Surplus Public Deposit Borrowings of which from Banks & FIs* Other Liabilities Application 1. Investments i) SLR Securities @ 4.18 11.79 20.90 31.86 NA 31.27 11.26 8.57 6.13 12.62 10.90 64.01 30.18 6.34 10.99 6.21 4.83 14.87 6.47 65.94 39.21 7.90 11.44 0.77 4.67 12.07 4.28 66.84 45.99 12.14 15.27 8.83 4.38 4.95 11.66 12.20 2.74 2.56 67.83 72.47 37.56 44.45 13.39 7.82 15.03 20.34 9.58 12.20 4.13 12.92 3.00 68.01 49.71 11.92 19.63 10.23
2011p 3.46 12.81 3.85 66.22 50.59 13.66 20.01 12.79
ii) Other Investments 2.68 4.78 10.66 6.44 5.45 8.13 9.41 7.22 2. Loan & Advances** 31.60 35.41 28.25 22.78 25.24 27.98 75.29 73.89 3. Hire Purchase Assets 32.58 40.00 52.89 54.01 44.96 46.44 4. Equipment Leasing 12.45 5.62 3.97 2.81 1.41 0.79 Assets 5. Bill business 1.95 1.31 0.12 0.01 0.02 0.03 0.05 0.08 6. Other Assets 8.04 6.67 3.33 5.12 13.34 4.42 4.83 6.01 7.Accumted. balance of 2.13 0.00 0.00 0.00 0.00 0.00 0.00 0.00 loss NA = Not available P : Provisional @ : SLR Asset comprises ‘approved securities’ and ‘unencumbered term deposits’ in Scheduled Commercial Banks. * : percentage share to total borrowings. ** : Break-up into hire purchase and equipment leasing for 2010 and 2011 not available. Source: worked out based on the absolute figures available from the Report on Trend and Progress in Banking in India, various volumes, RBI.
Banks’ Exposure to NBFCs In the context of the recent global crisis, it was observed that undue reliance on borrowed funds can be a source of risk and a more stable retail base of deposits are good for both the bottom line and resilience of 14 the financial institutions. In that context, analysis of liabilities side of the balance sheets of NBFCs revealed that the major sources of finance are public deposits, debentures, borrowings, commercial papers and inter-corporate loans. Liabilities of the consolidated balance sheets of NBFCs revealed that borrowings constitute the largest size of liabilities, even for the deposit taking NBFCs; corresponding to this, the size of public deposits are very miniscule as pointed out earlier. The consolidated balance sheets of NBFCs (both the categories i.e., deposit taking and non-deposit taking and systemically important companies) revealed that more than 68 per cent of the consolidated balance sheet constitutes borrowings. Out of which, 30 per cent resources are borrowed from banks and financial institutions as at the end of March 2011. These borrowings are in the forms of direct advances and loans (both secured and unsecured). These apart, borrowings by way of debentures issued by the NBFCs constituted around 33 per cent and of which a sizable portion is subscribed by the banking system. Both of these are on the rise over a period (Chart 3).
Banks Exposure to Deposit taking NBFCs-D For the deposit taking NBFCs, it is significant to note that, the proportion of public deposits outstanding is reduced to just around 3.8 per cent of their total liabilities as at the end of March 2011 from 20.9 per cent as at the end-March 2001. With tightening of the prudential regulatory norms in respect of deposit taking companies, NBFCs’ zest to raise public deposits seems to be fading, and the public deposit is increasingly being substituted with their reliance on other forms of sources, viz., mainly borrowings. A closer analysis of the sources of funds revealed that their total borrowings as at the end of March 2009 constituted as much as 72.5 per cent of their total liabilities (which increased from 31.8 per cent as at the end of March 2001), which came down to 66.2 per cent by end-March 2011. Understandably, borrowings are mainly from within the financial system, viz., banks and financial institutions (nearly half of the total borrowings), which besides showing the close financial interconnectedness within the financial system, also underscores higher systemic risks of the financial system in certain extreme circumstances (Table 3 and Chart 4).
Table 3 : Key Liabilities of Deposit taking NBFCs@ (end-March) (per cent to total) Liabilities 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011p Paid up Capital 4.18 5.46 7.58 7.11 6.22 4.83 4.67 4.38 4.95 4.13 3.46 Reserves & Surplus 11.79 10.48 12.58 13.48 11.39 14.87 12.07 11.66 12.20 12.93 12.81 Public Deposit 20.90 15.06 13.35 13.18 10.77 6.47 4.28 2.74 2.56 3.00 3.90 Borrowings 31.85 45.23 58.54 63.66 64.01 65.94 66.84 67.83 72.47 68.00 66.22 Other Liabilities 31.27 23.76 1.56 2.58 7.07 7.90 12.14 13.39 7.82 11.92 13.70 Total Liabilities 25,604 29,895 26,355 32,754 36,003 37,828 48,554 74,562 77,128 94,212 1,05,431 (Rs.crore) P: Provisional @: Excluding Residuary Non-Banking Financial Companies (RNBCs) Source: Author’s calculation based on Data from Report on Trend and Progress of Banking in India, various volumes, RBI
It is clear that the banking system is the major source of funding for NBFCs, both directly and indirectly, though banks have been prescribed with prudential ceiling on their exposures to the NBFCs. Till recently,
banks had the incentive for lending to NBFCs as such loans were permitted to be classified as ‘priority 15 sector’ lending by the banks . Incidentally, NBFCs are the major issuers in CPs segment which was as high as 62 per cent of the market size of Rs. 44,171 crore at end-March 2009 this share, however, came 16 down to around 48 per cent in a market size of Rs. 1,23,400 crore by end-June 2011 . This kind of high dependability of NBFCs on the banking system would mean systemic vulnerability in the context that NBFCs are involved in higher risk activities vis-à-vis the banking system. For instance, NBFCs do not have any exposure limit on their capital market related activities unlike the banking system. Moreover compared with regulation of banking sector, NBFCs in general, are less stringently regulated as pointed out by various Committees and Working Groups. However, it needs to be underlined that there has been substantial progress over the period towards bringing the regulatory norms relating to NBFCs on par with the banking system. Nevertheless, it needs to be underlined that, the protective cover available for the depositors of banks through the Deposit Insurance and Credit Guarantee Corporation (DICGC) are also absent for the depositors of NBFCs-D. The seriousness of high financial interconnectedness/ interdependencies was also highlighted by the Financial Stability Report of RBI (2010). The report stated that immediately after the Lehman Brothers collapse, NBFCs faced with the pressure of withdrawal from the mutual funds which subscribed to the short term NBFC debt were unable to either rollover or extend further credit and this created a liquidity crisis. This type of situation would have thrown the system out of gear had not the Reserve Bank of India, being the lender of last resort, and the Government taken appropriate liquidity support measures.
The higher borrowings of NBFCs, especially from the banking system raise some concerns about their liquidity position. More so, if such reliance happens to increase further. Incidentally, as can be seen from the Chart 4, the banking system’s exposure to NBFCs-D has considerably increased over the years. These concerns will be further accentuated in case the banks’ own liquidity position becomes tight at the time of crisis or even at crisis like situation. Analysing the sectoral deployment of credit by the banking system also revealed the fact that their lending to NBFCs have been on the consistent increase from 2007 to 2011 from around 2.75 per cent in May 2007 to 4.80 per cent by March 2011 confirming NBFCs’ reliance on the banking system for their major chunk of funds. Though this percentage is apparently smaller, any failure or crisis at few NBFCs can still have its implications.
Incidentally, it may be worth being pointed out that the mutual funds also have a sizable exposures to NBFCs by subscribing to instruments, viz., debentures, CPs and securitised debts issued by the NBFCs. Accordingly, at the end of October 2010 mutual funds exposure accounted around 16.6 per cent of the total exposures to debt related instruments and it came down to 11.8 per cent by end-March 2011. Non-Deposit taking Systemically Important NBFCs (NBFCs-ND-SI) In India, as pointed out earlier, among the non-deposit taking NBFCs, the large NBFCs with Rs. 100 crore 17 and above assets size have been classified as systemically important financial institutions (NBFC-NDSI). As these NBFCs are not raising resources by way of public deposits, they are regulated with fewer rigors compared with NBFCs-D. Even this type of reclassification of NBFC-ND-SI came into existence since mid-2006 although, the Reserve Bank has initiated measures effective 2000 to reduce the scope of ‘regulatory arbitrage’ between banks, NBFCs-D and NBFCs-ND (RBI, 2008) recognising their importance, essentially from the systemic stability point of view. With the recent happening of global financial crisis and aftermath, the regulators’ attention world over has received increased attention towards the systemically important financial institutions (SIFIs). Even in the case of India, the extant prudential regulation of NBFCs-ND-SI are endeavoured to bring convergence with that of the deposit taking NBFCs. Accordingly, it is advisable to introduce the return relating to balance sheets on a monthly basis and a more detailed returns encompassing the whole operations of the companies on completion of their annual accounts, as against the quarterly, half yearly annual returns to be filed by the deposit taking NBFCs. It is also worth being pointed out that there are also NBFCs-ND with assets size of less than Rs. 100 crore which are further classified into NBFCs-ND with asset size of Rs 50 crore and above but less than Rs. 100 crore, in respect of which monitoring is done only with respect to their assets size. The other smaller NBFCs are outside the purview of the Reserve Bank’s regulatory and supervisory ambit. It is intriguing to note that the total size of the balance sheet of NBFCs-ND-SI reached to Rs. 7,30,366 crore as at the end of March 2011, from Rs.1,70,957 crore as at the end of March 2005 growing more than four fold. It is even more interesting to note that the NBFCs-D which is a better regulated segment vis-à-vis NBFC-ND-SI makes up to just around 14 per cent of the latter. In other words, the systemically important non-deposit taking NBFCs have grown faster by nearly 7 fold as at the end of March 2011 when compared with the size of deposit taking NBFCs. As NBFC-ND-SI companies are not permitted to raise public deposits, borrowings constitute the major component of their liabilities at around 74 per cent by end of March 2005. This proportion got mellowed down to around 65 per cent by end-March 2009 reflecting subtle effect of the global crisis and the aftermath, as there was no direct impact on the Indian financial system. However, this proportion gone up to 69 per cent by end of March 2011. From the point of view of systemic interconnectedness, it is important to examine the proportion of loans and advances from the banks and financial institutions to total borrowings, accordingly it constituted 25 per cent of the total borrowings (both secured and unsecured) of NBFCs-ND-SI by end-June 2010 (Chart 5) which increased to 30 per cent by end-March 2011. These are direct borrowings in the form of loans and advances from the banks and FIs. Besides, indirectly, even assuming that major portion of the debentures, securitised debts and CPs issued by NBFCs are subscribed by the banking system, this portion alone forms another 30 to 35 per cent of the total borrowings. Thus in any case, the large chunks of resources are coming from the banking system to NBFCs. The argument therefore, is to put more checks and balances on the banking system’s exposures to NBFCs. To be precise, this is aimed to avoid any serious systemic consequences if either side of the institutions show some symptoms of trouble. To put more specific question; is there a corrective mechanism before it builds up a system level crisis. If there are any trouble among the NBFCs-ND-SI, there is a possibility to spill over to the banking system and also the mutual funds and thereby to the rest of the financial system, especially as the banks are largely based with the short term deposits, while the NBFCs, in general, are known for the medium to long term financing and high risk taking activities. Ceteris Paribus, it has the implications for mis-matches in the assets-liabilities of NBFCs, though this is subject to more detailed analysis of the maturity pattern of 18 the assets and liabilities buckets . Further, it may be cited that ‘…it is possible for an NBFC to conduct
some other non financial activity by deploying funds in non-financial assets…’ (RBI, 2011). Similar views have also been expressed by the Report of the recent Working Group on Issues and Concerns in the NBFCs Sector (Chairperson: Usha Thorat, 2011). Therefore, it calls for introspection for the regulators whether it is sufficient to fix a ceiling from the banks’ level. As a long term remedy, efforts need to be in the development of private bond market as that would serve better for diversifying the sources of funds for NBFCs.
It needs to be underlined that higher dependency of NBFCs on the banking system for their resources will not only strain banks at the time of crisis but also place NBFCs themselves into vulnerable situation. For, there are possibilities that banks can become over sensitive to a liquidity crisis or imminent crisis and they can either become too reluctant to lend to NBFCs or at the extreme case, they may completely refrain from lending to NBFCs which would further precipitate the situation, especially when NBFCs are in dire need of funds. The recent global crisis is a pointer in this direction. Further, this type of situation would compel NBFCs to turn to money market with higher costs to wade over the tight liquidity conditions impacting the money market as well. It may also be pointed out that a significant portion of their funds are also being funded by the mutual funds (RBI, 2010A). Even here similar situations are possible: NBFCs were stressed as bank loans to them had dried up and interest rates had increased in money markets, leading to higher costs of borrowing (RBI, 2010). It may be pointed out that NBFCs are also having exposures to banking system as they keep their funds in the form of fixed deposits, albeit it constitutes relatively a smaller proportion of say 11 to 12 per cent of their total assets. Even if NBFCs are not deposit taking and therefore, the question of repayment commitment of the depositors’ money does not arise, any failure of even such institutions will result in the losses that will ultimately have a cascading effect on the entire system, therefore all the institutions should come under closer scrutiny. The underlying principle to regulate these NBFCs are ‘to regulate similar risks in a similar manner’ irrespective of whether they take public deposits or otherwise. Presently, the definition of ‘systemically important’ is based only on the size of assets of NBFCs and this seems to be inadequate and highly simplistic. The size of liabilities/assets alone is not a sufficient condition for the systemic importance. This requires refinement by taking into account the intricate inter-
connectedness (both organically and financially) with the rest of the institutions within the financial system and also abroad, since intricate connectedness increases the systemic risk. For instance, a recent report from Financial Stability Board pointed out that besides the size, the degree of inter-connectedness, the degree of substitutability of the activities undertaken by the institution are to be taken into account to benchmark an institution as ‘systemically important’. The types of business activity as well as the complexity of the activity of the institutions are also necessary for redefining the ‘systemic importance’. Thomson (2009) suggested for regulatory attention to deal with the four ‘C’s (Contagion, Concentration, Correlation and Context or Condition) to identify the institutions which are systemically important. According to him, ‘contagion’ refers to failure of institution which has the potential of transmitting to other institutions/ market. ‘Concentration’ refers to the size and substitutability aspects of a particular institution in the system. ‘Correlation’ refers to (i) institution take on risks that are highly correlated with other institutions and (ii) potential for largely uncorrelated risk exposures to become highly correlated in periods of financial stress. It is also known as the ‘too many to fail’ problem. Condition/ context, of course, refer to the judgment of a particular context or situation in which an institution becomes systemically important. It also refers to the probability that economic or financial conditions if materialise that produce the state of nature where a firm becomes systemically important. Although banks and NBFCs compete for similar kinds of business on the assets side, NBFCs distinguish themselves by offering wide range of products/ services such as leasing and hire-purchase, financing of used commercial vehicles, corporate loans, investment in non-convertible debentures, IPO funding, margin funding, small ticket loans, venture capital, equity and debt investments, etc. In most of these areas either banks are reluctant to finance or finance to a very limited extent. Since the regulatory and cost-incentive structures are not identical for banks and NBFCs and that NBFCs borrow funds from banks to on-lend, it is necessary to establish adequate checks and balances to ensure that the banks’ depositors are not indirectly exposed to the risks of a different cost-incentive structure. Moreover, as NBFCs are well known to venture into the areas not permitted for the banks and in such cases, large scale exposures to NBFCs tantamount to banks entering into those areas in an indirect route. There was a substantial change in the risk perception in 1990s, world over, about the non-banking financial activities. This was one of the strong reasons for the passage of Graham Leach Bliley (GLB) Act in the US which till then separated the traditional banking from the modern day financial activities under the erstwhile Glass Steagall Act. With the passage of GLB Act, banks were permitted to pursue financial activities in the form of universal banking framework. Accordingly, the non-banking financial activities also amplified multi-fold in the US during the post GLB Act. However, the global financial crisis has proved the fact that greater risks to banks particularly came in newer forms of non-banking activities such as sponsoring of securitisation SPVs and private pools of capitals (RBI, 2011). In that context, the banking sector will be affected with growing interconnectedness with non-banking business, in case NBFCs continued to have less than par regulation and supervision with that of banks. This is not to advocate that NBFCs borrowings from banks per se will result in crisis, it is only intended to caution that excess dependency on banking sector will only exasperate if a crisis like situation arises. In view of the above, the work is also underway on structural methodologies to identify systemic importance at the IMF, the BIS and the national central banks and academia based on inputs capturing size, probabilities of failure, similarities in exposures and interconnectedness (FSB, 2011).
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2. 1974 - Chapter V (on Penalties) was inserted in RBI Act, 1934. 3. February 15, 1984 - Chapter lll C (to regulate deposit taking activities of UIBs) was inserted in RBI Act, 1934. 4. 1992 - Working Group on Financial Companies by RBI (Chairman: Dr. A.C. Shah). Reserve Bank of India Act, 1934, did not confer RBI with adequate powers to make the recommendations mandatory. 5. April 1993 – System of registration for NBFCs with NoF Rs. 50 lakh and above was introduced. 6. June 1994- RBI prescribed prudential norms as an attempt to regulate the assets of the companies. 7. 1995 ? ? Khanna Committee (Expert Group on Designing a Supervisory framework for NBFCs) .Recommendations laid foundation to the supervisory framework of NBFCs. The supervision of the NBFC sector was brought under the jurisdiction of the Board for Financial Supervision (BFS) (July 01).
8. 1997 - Department of Non-Banking Supervision (DNBS), was formed by segregating FCW from DoS, for focused attention to the supervision of NBFCs by 16 Regional Offices. 9. March 1997 - the Reserve Bank of India (Amendment) Act was passed amending Chapter lll B, lll C and V of RBI Act, 1934. 10. April 30, 1997 - Reserve Bank of India (Non-Banking Financial Companies) Returns Specifications 1997 was issued. 11. January 02, 1998 - New Regulatory Framework for NBFCs ? NBFCs were classified into 3 categories for purposes of regulation, viz, (i) those accepting public deposits; (ii) those which do not accept public deposits but are engaged in the financial business, and (iii) core investment companies which hold at least 90 per cent of their assets as investments in the securities of their group/holding/subsidiary companies. New entry point norm of Rs. 25 lakh. While NBFCs accepting public deposits were to be subjected to the entire gamut of regulations, those not accepting public deposits would be regulated in a limited manner. In respect of new NBFCs (which are incorporated on or after April 20, 1999 and which seek registration with the Reserve Bank), the minimum NOF was raised to Rs. 2 crore.
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12. January 31, 1998 - Directions were issued as under: ? ? Non-Banking Financial Companies Acceptance of Public Deposits (Reserve Bank) Directions, 1998 Non-Banking Financial Companies Prudential Norms (Reserve Bank) Directions, 1998
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Non-Banking Financial Companies Auditor’s Report (Reserve Bank) Directions, 1998.
13. August 1998- Task Force on Non-Banking Finance Companies under the Chairmanship of Shri C M Vasudev, Special Secretary (Banking), Ministry of Finance to examine the adequacy of then legislative framework was set up. 14. October 1998 - The Task Force submitted its Report to the Government. Recommendations included: ? ? ? higher CRAR for NBFCs than banks, statutory powers to RBI to appoint depositors' grievance redressal authorities, review of prudential norms etc.
15. April 08, 1999 – Press Release issued by RBI defining principal business. A company will be treated as an NBFC ? ? ? if its financial assets are more than 50 per cent of total assets (netted off against intangible assets) and income from financial assets is more than 50 per cent of the gross income. both these criteria are required to be fulfilled as the determinant factor for principal business of a company.
16. January 13, 2000 – On the lines of scheduled commercial banks, all NBFCs having asset size of Rs. 50 crore or above were advised to have compulsory internal audit system and also constitute an Audit Committee from among the members of their Board of Directors. 17. January 13, 2000 – Exemptions were granted to NBFCs (Section 25 Companies) engaged in micro financing activities, MBCs (Potential Nidhis) and Government companies (registration applicable) from Core provisions of RBI Act, 1934 and Directions, subject to eligibility criteria. 18. June 09, 2000 - Guidelines for entry of NBFCs into insurance business was issued. 19. December 13, 2000 - Financial Companies Regulation Bill, FCRB was introduced in the Lok Sabha. The Standing Committee on Finance submitted its report in July 2003, making 21 recommendations for amendments in the FCRB. The Committee recommended that only deposit taking companies should be covered under the new legislation. 20. June 27, 2001 – The concept of asset liability management was introduced in 2001 for all NBFCs with asset base of Rs. 100 crore or holding public deposits of Rs. 20 crore or more. 21. November 28, 2002 - Venture Capital Fund Companies registered with SEBI and not holding public deposits were exempted from core provisions of RBI Act and Directions. 22. January 08, 2003 - Stock broking companies, registered with SEBI and not holding public deposit were exempted from core provisions of RBI Act and Directions. 23. March 29, 2003 - As part of implementation of the recommendation of the Working Group on Redesigning of Financial Statements of NBFCs, additional schedule to Balance Sheet of NBFCs was stipulated for all NBFCs. 24. June 18, 2003 - In terms of amended FEMA Notification No. 94 dated June 18, 2003, Foreign Direct Investments (FDI) was permitted under automatic route for 18 specified NBFC activities subject to minimum capitalisation norms.
25. 2004 - Several all India associations and State level associations formed a Self Regulatory Organisation named Finance Industry Development Council (FIDC). 26. June 2004 – Discussions were held with NBFCs regarding their plan of action for voluntarily phasing out of their acceptance of public in line with international practices. NBFCs-ND were advised that they would require Rs. 2 crore NoF before applying for permission to accept public deposits. 27. February 2005 - the Government of India (GOI) was advised by RBI that a separate legislation, viz., FCRB 2000, for financial companies was not necessary since the initiatives taken by RBI and the change in the composition of the sector, had addressed the issues to a great extent. 28. September 06, 2005 - A system of monitoring the capital market exposure of NBFCs-ND-SI through monthly returns was brought in. 29. December 2005 - The concept of Corporate Governance was introduced in 2005 with directions to rotate partners of statutory auditors after three years and further elaborated in August 2007. 30. September 28, 2006 - Guidelines on Fair Practices Code was issued to NBFCs. 31. December 06, 2006 - A new category of NBFCs formed as Asset Finance Companies by combining the classes of Equipment Leasing and Hire Purchase Companies. 32. December 12, 2006 ? ? ? ? Systemic significance of the sector was recognized and NBFCs with asset size of Rs. 100 crore and above classified as systemically important companies Capital adequacy requirements and credit concentration norms introduced. NBFCs allowed to issue co-branded credit cards with scheduled commercial banks without risk sharing and with prior approval of RBI subject to certain eligibility criteria.
33. February 22, 2007 - The need for differential regulation was recognized for deposit taking and non deposit taking companies and separate prudential norms were issued for them in February 2007. 34. April 27, 2007 - submission of an annual statement of capital funds, risk asset ratio etc., as at end of March every year in form NBS-7 was stipulated for NBFCs-ND-SI. 35. August 01, 2008 - Guidelines for NBFC-ND-SI as regards capital adequacy, liquidity and disclosure norms was issued ? ? ? Increase in Capital adequacy to 12% w.e.f March 31, 2010 and 15% w.e.f March 31, 2011 introduction of ALM reporting and disclosure norms for NBFC-ND-SI
36. September 24, 2008 – NBFCs with asset size of Rs. 50 crore and above but less than Rs. 100 crore were advised to submit online, a quarterly return on important financial parameters. 37. October 29, 2008 - NBFCs-ND-SI were permitted to issue Perpetual Debt Instruments (PDI) in accordance with the guidelines issued. 38. September 17, 2009 – Instructions on takeover / acquisition of a deposit taking NBFC, would require prior permission of RBI were issued.
39. September 18, 2009 -NBFCs were allowed to participate in Interest Rate Futures market subject to prescribed conditions. 40. February 12, 2010 - New class of NBFCs viz; IFCs introduced and eligibility criteria stipulated. 41. July 09, 2010 - Issue of guarantees by NBFCs-ND-SI treated as akin to access to public funds for considering applications for special dispensation from exposure norms. 42. August 09, 2010 – NBFCs permitted to participate in currency futures only for hedging. 43. August 11, 2010 – NBFCs-ND-SI permitted to participate in repo of corporate debt securities. 44. August 12, 2010 and January 05, 2011 – Guidelines and Notification on Core Investment Companies (CICs) issued. 45. September 16, 2010 – NBFCs permitted to participate in currency options for hedging. 46. January 17, 2011 - Provisioning requirement for standard assets - a general provision at 0.25 per cent of the outstanding standard assets introduced. 47. Feb 02, 2011 - Gold loans not to be treated as agricultural loans and the priority sector status for such bank lending was removed (RPCD circular). 48. Feb 17, 2011 - CRAR requirement of NBFCs-D raised to 15% from the extant 12% w.e.f March 31, 2012. 49. March 30, 2011 - NBFCs were prohibited from contributing capital to any partnership firm or to be partners in partnership firms. 50. May 27, 2011 - contribution made by the group entities in an insurance JV along with the NBFC brought within the ceiling of 'not more than 50% of the paid up equity capital of the insurance JV'. Group concept in this case has been revised on the lines of CICs.
Growth of nbfcs 2.5 Profile of the NBFC Sector 2.5.1 The total number of NBFCs was 12,662 as on March 31, 2010, comprising 311 deposit taking NBFCs (NBFCs-D), 295 systemically important non deposit taking companies, (NBFCs-ND-SI) and 12,056 other non-deposit taking NBFCs (NBFC-ND). 2.5.2 The number of NBFCs-D (excluding RNBCs) and the amount of deposits held by them have been showing a sharp decline over the years. Table 1 and Chart 1 below show the trend in the amount of deposits held by them as a share of bank deposits for the years 1998, 2006 and 2010.
Table 1: NBFCs@ - Acceptance of Public Deposits (Rs. Crore) Year No. of Public Public Deposits Reporting Deposits as % of Bank Companies Deposits 1997-98 1420 13572 2.27% 2005-06 428 2448 0.12% 2009-10 280 2753 0.06% @ Excluding RNBCs
2.5.3 At the same time, the NBFC-ND-SI sector, which constitutes 70 per cent of total assets of NBFCs, recorded significant growth. Their number increased from 151 in March 2006 to 295 in March 2010, and their assets grew from Rs. 250,765 crore, to Rs. 566,853 crore in the same period. Table 2 and Chart 2 give the growth of assets in the NBFC sector as a whole, (NBFC-D and NBFC-ND-SI), since 1997-98.
Table 2: NBFCs@@ - Growth of Asset (Rs. Crore) Year No. of Reporting Total CAGR Total Assets as Companies Assets (%) % of total Bank Assets 1997-98 1420 34790 4.4 2005-06 586 288593 30.3 11.1 2009-10 575 661186 23.0 11.0 @@ Excludes RNBCs but includes deposit taking (NBFCs-D) and systemically important non-deposit taking NBFCs (NBFCs-ND-SI) which account for about 90% of total assets of the sector Data for the year 1997-98 includes only deposit taking NBFCs while other two periods, 2005-06 and 2009-10 includes deposit taking NBFCs and
NBFCs-ND having assets size Rs. 100 crore & above (ND-SI)
2.5.4 Table 3 and Chart 3 indicate that bank borrowings constitute an important source of funds for NBFCs. The NBFCs-ND-SI are significant from the systemic point of view as they also access public funds indirectly through commercial papers, debentures and inter-corporate deposits apart from bank finance. Table-4 and Chart 4 give the details in this regard.
Table 3: NBFCs@@ - Borrowings from Banks as Source of Funds (Rs. Crore) Year No. of Total Bank CAGR (Bank Bank Reporting Assets Borrowings Borrowings) Borrowings as Companies % of Total Assets 1997-98 1420 34790 5554 16.0 2005-06 586 288593 54171 32.9 18.8 2009-10 575 661186 121774 22.4 18.4 @@ Excluding RNBCs but include deposit taking and non-deposit taking NBFCs which account for about 80% of total assets of the sector (Source : Returns) Note: Data for the year 1997-98 includes only deposit taking NBFCs while other two periods, 2005-06 and 2009-10 includes deposit taking NBFCs and NBFCs-ND having assets size Rs. 100 crore & above (ND-SI)
Table 4: NBFCs@@ - Sources of Funds 200910 Owned Fund 65068 161288 218454 (22.5) (24.4) (25.9) Public Deposits 2667 2753 3935 (0.9) (0.4) (0.5) Bank Borrowings 53188 120986 176879 (18.4) (18.3) (21.0) Debentures 68138 154109 186883 (23.6) (23.3) (22.2) Commercial Papers 13785 35546 33672 (4.8) (5.4) (4.0) Inter-Corporate Borrowings 19718 19898 25972 (6.8) (3.0) (3.1) Others 66029 166607 196854 (22.9) (25.2) (23.4) Total Assets 288593 661187 842649 (100.0) (100.0) (100.0) @@ Excludes RNBCs but include deposit taking (NBFCs-D) and systemically important non-deposit taking NBFCs (NBFCs-NDSI)which account for about 90% of total assets of the sector Note: Data for the year 1997-98 includes only deposit taking NBFCs while other two periods, 2005-06 and 2009-10 includes deposit Year 2005-06 (Rs. Crore) 2010-11
taking NBFCs and NBFCs-ND having assets size Rs. 100 crore & above (ND-SI) Note: Others include interest accrued, borrowings from relatives, deferred credits and other borrowings
2.5.5 Category wise profitability of NBFCs: Table 5 and Chart 5 show the growth of assets as per type of NBFCs while Table 6 and Chart 6 gives the ROE, ROA and leverage ratio for various types of NBFCs.
Table 5: Growth of Assets as per type of NBFCs (yoy %) NBFCs (Rs. Crore) Year 2006-07 2007-08 2008-09 2009-10 2010-11 Asset Finance Companies 52261 73598 97686 113951 138074 (40.8) (32.7) (16.7) (21.2) Investment Companies 119191 115677 121267 143244 153683 -(2.9) (4.8) (18.1) (7.3) Loan Companies 182351 244884 371102 403992 497580 (34.3) (51.5) (8.9) (23.2) Total Assets 353803 434159 590055 661187 789337 (22.7) (35.9) (12.1) (19.4) Figure in brackets represents percentage growth rates on year-on-year basis Note: Loan companies include infrastructure finance companies, MFIs and gold loan companies and Govt. companies Note : The above data pertains to both NBFC-D and NBFC-ND-SI
Table 6: Profitability Indicators of NBFCs, As on Mar 31, 2010 Type of NBFC Total Return on Assets Return on Equity Leverage Ratio Assets (%) (%) (%) NBFCs-D ND-SI NBFCs-D ND-SI NBFCs-D ND-SI Public Sector NBFCs 61988 2.9 1.1 22.2 11.0 13.1 10.1 IFCs 196158 NA 2.8 NA 16.3 NA 17.1 AFCs 113951 2.8 1.3 19.8 8.5 14.2 15.1 Gold Loan Companies 8650 4.6 3.9 19.4 37.4 23.9 10.5 MFIs 13675 NA 3.7 NA 21.4 NA 17.4 Other Loan & investment 266764 4.5 1.7 6.0 3.8 75.9 44.5 Companies All NBFCs 661186 3.0 2.0 19.4 7.1 15.6 28.6 Note: 1. NBFCs-D=Deposit taking NBFCs and ND-SI=non-deposit taking systemically important NBFCs (NBFCs-ND with assets size Rs. 100 crore & above) Note: 2. Leverage Ratio = Tier-I Capital as a % to Total Assets Source: Annual Returns on NBFCs-D and ND-SI
Residuary Non-Banking Companies (RNBCs) 5.18 RNBCs are a class of NBFCs which cannot be classified as equipment leasing, hire purchase, loan, investment, nidhi or chit fund companies, but which tap public savings by operating various deposit schemes, akin to recurring deposit schemes of banks. The deposit acceptance activities of these companies are governed by the provisions of Residuary Non-Banking Companies (Reserve Bank) Directions, 1987. These directions include provisions relating to the minimum (not less than 12 months) and maximum period (not exceeding 84 months) of deposits, prohibition from forfeiture of any part of the deposit or interest payable thereon, disclosure requirements in the application forms and the advertisements soliciting deposits and periodical returns and information to be furnished to the Reserve Bank.
5.19 In the absence of any linkage of deposits to their NOF, to safeguard the depositors' interests, these companies have been directed to invest not less than 80 per cent of aggregate deposit liabilities as per the investment pattern prescribed by the Reserve Bank, and to entrust these securities to a public sector bank to be withdrawn only for repayment of depositors. Subject to compliance with the investment pattern, they can invest 20 per cent of aggregate liabilities or ten times its net owned fund, whichever is lower, in a manner decided by its Board of Directors. 5.20 The RNBCs are the only class of NBFCs which are enjoined to pay a minimum rate of interest on their deposits. The floor rate of interest for deposits are specified by the Reserve Bank in terms of RNBC Directions, 1987. There is no upper limit prescribed for RNBCs unlike other NBFCs, which can pay any rate of interest subject to the maximum ceiling prescribed by the Reserve Bank. The floor interest rate payable by RNBCs was revised downwards from 6 per cent to 4 per cent per annum (to be compounded annually) on daily deposit schemes and from 8 per cent to 6 per cent per annum (to be compounded annually) on other deposit schemes of higher duration or term deposits. The provisions of prudential norms were extended to RNBCs, under the provisions of the NBFC Prudential Norms (RB) Directions, 1998 and compliance with prudential norms is mandatory and a prerequisite for acceptance of deposits. 5.21 Monitoring and inspection of these companies, from time to time, revealed continuance of many unsatisfactory features like non-compliance with the core provisions of the Directions, forfeiture of the depositors' money on one pretext or the other, diversion of depositors' money to associate concerns and/or investment in illiquid assets, violation of investment requirements/pattern, etc., thus jeopardising the interests of depositors. The Reserve Bank was issuing prohibitory orders on a case-by-case basis restraining erring RNBCs from accepting deposits. Some of the ingenious promoters floated new companies and started accepting deposits through new entities or shifted their area of operations to other States. The requirement of compulsory registration before commencing business of RNBC and concerted action taken against such companies has curbed such practices to a large extent. 5.22 The Reserve Bank received 106 applications for Certificate of Registration (CoR) from NBFCs which were functioning as RNBCs by accepting deposits under some scheme or arrangement. While 12 companies subsequently converted themselves to NBFCs, applications of 84 companies have been rejected. Ten NBFCs are still functioning as RNBCs, the total deposits of which amounted to nearly Rs. 11,000 crore, constituting about 57.0 per cent of the total deposits of all reporting NBFCs.
New
the role of Non-Banking Finance Companies (NBFCs) in transferring the funds from lenders to borrowers has been well-recognized. The main advantages of these companies lie in the lower transactions costs of their operations, their quick decision-making ability, customer orientation and prompt provision of services. Partly on account of these advantages, NBFCs have in recent years grown sizeably both in terms of their numbers as well as the volume of business transactions The rapid growth of the NBFCs sector can also be attributed to other factors. NBFCs were historically subjected to a relatively lower degree of regulation vis-à-vis banks. Secondly, the higher rates of return on deposits offered by NBFCs have enabled them to attract a large base of small savers. Added to these was the fact that the operations of NBFCs were characterized by several distinctive features viz., no entry barriers, limited fixed assets and no holding of inventories-all of which led to a proliferation of NBFCs. The growing role of NBFCs was recognized by the second Narasimham Committee (1998) as well as by the Reserve Bank of India in its Discussion Paper on Harmonisation of the Role and Operations of DFIs and Banks, as also in the Report of the Working Group on Money Supply (Chairman: Dr. Y.V. Reddy)
Size of NBFCs Sector and their Growth http://www.rbi.org.in/scripts/PublicationsView.aspx?Id=13979
In line with the global trend, NBFCs in India too emerged primarily to fill in the gaps in the supply of financial services which were not generally provided by the banking sector, and also to complement the banking sector in meeting the financing requirements of the evolving economy. Over the years NBFCs have grown sizably both in terms of their numbers as well as the volume of business transactions (RBI, 2009). The number of such financial companies grew more than seven-fold from 7,063 in 1981 to 51,929 8 in 1996. Thus, the growth of NBFCs has been rapid, especially in the 1990s owing to the high degree of their orientation towards customers and simplification of loan sanction requirements (RBI, 2000). Further, the activities of NBFCs in India have undergone qualitative changes over the years through functional specialisation. NBFCs are perceived to have inherent ability and flexibility to take quicker decisions, assume greater risks, and customise their services and charges according to the needs of the clients. These features, as compared to the banks, have tremendously contributed to the proliferation of NBFCs in the eighties and nineties. Their flexible structures allowed them to unbundle services provided by banks and market the components on a competitive basis. Banks on the other hand, had all along been known for their rigid structure, especially the public sector banks. This compelled them carry out such services by establishing ‘banking subsidiaries’ in the form of NBFCs. The willingness of NBFCs to engage in varied forms of financial intermediation, hitherto unavailable to the banking system, has provided the valuable flexibility in financing new areas of business. Though the NBFCs are different species and smaller in size as a segment when compared with the banking system, their relevance to the overall economic development and to certain specified areas cannot be undermined. Over a period as the regulatory requirements were made progressively stringent, the total number of NBFCs registered with the Reserve Bank stood at 12,409 by end-March 2011. The number of NBFCs-D declined considerably with conversion into non-deposit taking companies, besides closure and mergers of weaker companies. Incidentally, the regulatory regime also seems to be in favour of reducing the number of deposit taking NBFCs and consequent migration of depositors towards the banking system which is better regulated and supervised in line with the global standards. It may be underlined that the public deposits of NBFCs, after showing a steady increase till 2007, declined thereafter and sharply by end-March 2011. However, the size of total assets, have grown more than double from Rs. 53,878 crore as at end-March 2001 to Rs. 1,16,897 crore by end-March 2011, clearly indicating greater demand for the services provided by these companies in a fast growing economy (Table 1). The net owned fund (NoF) of NBFCs has also increased sharply between end-March 2001 and end-March 2011 by more than three times to Rs. 17,975 crore, showing the strength of the NBFCs segment.
Table 1: Profile of Non-Bank Finance Companies in India (end-March) Item No of COs registered with RBI@ 875 981 573 466 362 364 336 308 297 No of reporting 981 910 companies* Total Assets* 53,878 58,290 58,071 53,878 52,900 57,453 71,171 94,744 97,408 1,12,131 1,16,897 (20,362) (17,955) (19,056) (21,891) (23,172) (24,452) (20,280) (17,919) (11,466) (Amount in Rs.crore) 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 13815 14077 13849 13764 13261 13014 12968 12809 12740 12630 12409
Public Deposits* Net Owned Fund*
18,085 18,822 20,100 18,085 20,246 22,842 24,665 24,395 21,548 17,352 11,964 (15,065) (15,327) (16,600) (20,175) (22,622) (22,358) (19,595) (14,521) (7,902) 4,943 4,383 4,950 4,943 5,510 6,663 8,601 12,261 13,458 16,424 17,975
(809) (1,002) (1,065) (1,183) (1,366) (1,718) (1,870) (2,921) (2,988) @ This includes all NBFCs (both deposit taking and non-deposit taking). * NBFCs include Deposit taking NBFCs (NBFCs-D), Mutual Benefit Financial Companies (MBFCs) (Notified Nidhis), Mutual Benefit Companies (MBCs) (Potential Nidhis) etc, till 2004-05 and only NBFCs-D thereafter. Note: Figures in brackets relates to RNBFCs. Source: Report on Trend and Progress of Banking in India various issues.
Over the years, especially with the Reserve Bank’s regulation becoming progressively more broad-based and stringent, the size of the NBFCs (in terms of numbers) as a segment has been reduced drastically as most of the unviable and substandard companies disappeared from the scene. It is also clear from the percentage share of non-banking deposits of household sector saving in gross financial assets, which decreased from around 4.0 per cent in 1997-98 to 1.8 per cent in 2008-09 (chart 1).
Further, the ratio of deposits of NBFCs to aggregate deposits of scheduled commercial banks (SCBs) showed a consistent decline revealing the regulatory focus of the Reserve Bank which emphasised on the discouragement of deposit taking NBFCs.
Thus, in comparison with the banking system in India the size of deposits in respect of NBFC-D showed a constant decline over a period and reduced to very small in size (Chart 2). Interestingly, the ratio of NBFC-D assets to banking sector since 2006 seems to have reversed from the declining trend as their asset size began swelling, though when compared with the banking system it is very small. As the size of deposits is not growing in tandem with the growth of their assets, obviously it becomes inquisitive to ascertain the source of funding the asset growth of NBFCs. In this context, analysis of sources and application of funds in respect of NBFCs-D revealed that among the sources, there is consistent increase in the borrowings and it emerged as the major source of finance to the tune of more than 72 per cent of the total liabilities at the end of March 2009. However, it slowed down to 66.7 per cent by end-March 2011. Even in the case of deposit taking NBFCs, public deposit as a share in the total liabilities have been drastically reduced to a meagre 3.85 per cent at the end-March 2011 from as high as 21 per cent in endMarch 2001, while the borrowings shot up. It is of particular significance to note that funding by banks and FIs have been on the increase to reach more than 50 per cent in the total borrowings (Table 2). On the deployment of funds, the major chunk is in the form of loans and advances and hire purchase assets together accounted for more than 73 per cent as at the end of March 2011. It needs to be underlined that they, by and large, are medium to long term assets, while major part of the funding of these assets are not of long term sources.
Table 2 : Sources and Application of Funds by the NBFCs-D (Percentage Share in the Total Assets/ Liabilities 2001 2005 2006 2007 2008 2009 2010 Sources Paid up Capital Reserves & Surplus Public Deposit Borrowings of which from Banks & FIs* Other Liabilities Application 1. Investments i) SLR Securities @ 4.18 11.79 20.90 31.86 NA 31.27 11.26 8.57 6.13 12.62 10.90 64.01 30.18 6.34 10.99 6.21 4.83 14.87 6.47 65.94 39.21 7.90 11.44 0.77 4.67 12.07 4.28 66.84 45.99 12.14 15.27 8.83 4.38 4.95 11.66 12.20 2.74 2.56 67.83 72.47 37.56 44.45 13.39 7.82 15.03 20.34 9.58 12.20 4.13 12.92 3.00 68.01 49.71 11.92 19.63 10.23
2011p 3.46 12.81 3.85 66.22 50.59 13.66 20.01 12.79
ii) Other Investments 2.68 4.78 10.66 6.44 5.45 8.13 9.41 7.22 2. Loan & Advances** 31.60 35.41 28.25 22.78 25.24 27.98 75.29 73.89 3. Hire Purchase Assets 32.58 40.00 52.89 54.01 44.96 46.44 4. Equipment Leasing 12.45 5.62 3.97 2.81 1.41 0.79 Assets 5. Bill business 1.95 1.31 0.12 0.01 0.02 0.03 0.05 0.08 6. Other Assets 8.04 6.67 3.33 5.12 13.34 4.42 4.83 6.01 7.Accumted. balance of 2.13 0.00 0.00 0.00 0.00 0.00 0.00 0.00 loss NA = Not available P : Provisional @ : SLR Asset comprises ‘approved securities’ and ‘unencumbered term deposits’ in Scheduled Commercial Banks. * : percentage share to total borrowings. ** : Break-up into hire purchase and equipment leasing for 2010 and 2011 not available. Source: worked out based on the absolute figures available from the Report on Trend and Progress in Banking in India, various volumes, RBI.
Banks’ Exposure to NBFCs In the context of the recent global crisis, it was observed that undue reliance on borrowed funds can be a source of risk and a more stable retail base of deposits are good for both the bottom line and resilience of 14 the financial institutions. In that context, analysis of liabilities side of the balance sheets of NBFCs revealed that the major sources of finance are public deposits, debentures, borrowings, commercial papers and inter-corporate loans. Liabilities of the consolidated balance sheets of NBFCs revealed that borrowings constitute the largest size of liabilities, even for the deposit taking NBFCs; corresponding to this, the size of public deposits are very miniscule as pointed out earlier. The consolidated balance sheets of NBFCs (both the categories i.e., deposit taking and non-deposit taking and systemically important companies) revealed that more than 68 per cent of the consolidated balance sheet constitutes borrowings. Out of which, 30 per cent resources are borrowed from banks and financial institutions as at the end of March 2011. These borrowings are in the forms of direct advances and loans (both secured and unsecured). These apart, borrowings by way of debentures issued by the NBFCs constituted around 33 per cent and of which a sizable portion is subscribed by the banking system. Both of these are on the rise over a period (Chart 3).
Banks Exposure to Deposit taking NBFCs-D For the deposit taking NBFCs, it is significant to note that, the proportion of public deposits outstanding is reduced to just around 3.8 per cent of their total liabilities as at the end of March 2011 from 20.9 per cent as at the end-March 2001. With tightening of the prudential regulatory norms in respect of deposit taking companies, NBFCs’ zest to raise public deposits seems to be fading, and the public deposit is increasingly being substituted with their reliance on other forms of sources, viz., mainly borrowings. A closer analysis of the sources of funds revealed that their total borrowings as at the end of March 2009 constituted as much as 72.5 per cent of their total liabilities (which increased from 31.8 per cent as at the end of March 2001), which came down to 66.2 per cent by end-March 2011. Understandably, borrowings are mainly from within the financial system, viz., banks and financial institutions (nearly half of the total borrowings), which besides showing the close financial interconnectedness within the financial system, also underscores higher systemic risks of the financial system in certain extreme circumstances (Table 3 and Chart 4).
Table 3 : Key Liabilities of Deposit taking NBFCs@ (end-March) (per cent to total) Liabilities 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011p Paid up Capital 4.18 5.46 7.58 7.11 6.22 4.83 4.67 4.38 4.95 4.13 3.46 Reserves & Surplus 11.79 10.48 12.58 13.48 11.39 14.87 12.07 11.66 12.20 12.93 12.81 Public Deposit 20.90 15.06 13.35 13.18 10.77 6.47 4.28 2.74 2.56 3.00 3.90 Borrowings 31.85 45.23 58.54 63.66 64.01 65.94 66.84 67.83 72.47 68.00 66.22 Other Liabilities 31.27 23.76 1.56 2.58 7.07 7.90 12.14 13.39 7.82 11.92 13.70 Total Liabilities 25,604 29,895 26,355 32,754 36,003 37,828 48,554 74,562 77,128 94,212 1,05,431 (Rs.crore) P: Provisional @: Excluding Residuary Non-Banking Financial Companies (RNBCs) Source: Author’s calculation based on Data from Report on Trend and Progress of Banking in India, various volumes, RBI
It is clear that the banking system is the major source of funding for NBFCs, both directly and indirectly, though banks have been prescribed with prudential ceiling on their exposures to the NBFCs. Till recently,
banks had the incentive for lending to NBFCs as such loans were permitted to be classified as ‘priority 15 sector’ lending by the banks . Incidentally, NBFCs are the major issuers in CPs segment which was as high as 62 per cent of the market size of Rs. 44,171 crore at end-March 2009 this share, however, came 16 down to around 48 per cent in a market size of Rs. 1,23,400 crore by end-June 2011 . This kind of high dependability of NBFCs on the banking system would mean systemic vulnerability in the context that NBFCs are involved in higher risk activities vis-à-vis the banking system. For instance, NBFCs do not have any exposure limit on their capital market related activities unlike the banking system. Moreover compared with regulation of banking sector, NBFCs in general, are less stringently regulated as pointed out by various Committees and Working Groups. However, it needs to be underlined that there has been substantial progress over the period towards bringing the regulatory norms relating to NBFCs on par with the banking system. Nevertheless, it needs to be underlined that, the protective cover available for the depositors of banks through the Deposit Insurance and Credit Guarantee Corporation (DICGC) are also absent for the depositors of NBFCs-D. The seriousness of high financial interconnectedness/ interdependencies was also highlighted by the Financial Stability Report of RBI (2010). The report stated that immediately after the Lehman Brothers collapse, NBFCs faced with the pressure of withdrawal from the mutual funds which subscribed to the short term NBFC debt were unable to either rollover or extend further credit and this created a liquidity crisis. This type of situation would have thrown the system out of gear had not the Reserve Bank of India, being the lender of last resort, and the Government taken appropriate liquidity support measures.
The higher borrowings of NBFCs, especially from the banking system raise some concerns about their liquidity position. More so, if such reliance happens to increase further. Incidentally, as can be seen from the Chart 4, the banking system’s exposure to NBFCs-D has considerably increased over the years. These concerns will be further accentuated in case the banks’ own liquidity position becomes tight at the time of crisis or even at crisis like situation. Analysing the sectoral deployment of credit by the banking system also revealed the fact that their lending to NBFCs have been on the consistent increase from 2007 to 2011 from around 2.75 per cent in May 2007 to 4.80 per cent by March 2011 confirming NBFCs’ reliance on the banking system for their major chunk of funds. Though this percentage is apparently smaller, any failure or crisis at few NBFCs can still have its implications.
Incidentally, it may be worth being pointed out that the mutual funds also have a sizable exposures to NBFCs by subscribing to instruments, viz., debentures, CPs and securitised debts issued by the NBFCs. Accordingly, at the end of October 2010 mutual funds exposure accounted around 16.6 per cent of the total exposures to debt related instruments and it came down to 11.8 per cent by end-March 2011. Non-Deposit taking Systemically Important NBFCs (NBFCs-ND-SI) In India, as pointed out earlier, among the non-deposit taking NBFCs, the large NBFCs with Rs. 100 crore 17 and above assets size have been classified as systemically important financial institutions (NBFC-NDSI). As these NBFCs are not raising resources by way of public deposits, they are regulated with fewer rigors compared with NBFCs-D. Even this type of reclassification of NBFC-ND-SI came into existence since mid-2006 although, the Reserve Bank has initiated measures effective 2000 to reduce the scope of ‘regulatory arbitrage’ between banks, NBFCs-D and NBFCs-ND (RBI, 2008) recognising their importance, essentially from the systemic stability point of view. With the recent happening of global financial crisis and aftermath, the regulators’ attention world over has received increased attention towards the systemically important financial institutions (SIFIs). Even in the case of India, the extant prudential regulation of NBFCs-ND-SI are endeavoured to bring convergence with that of the deposit taking NBFCs. Accordingly, it is advisable to introduce the return relating to balance sheets on a monthly basis and a more detailed returns encompassing the whole operations of the companies on completion of their annual accounts, as against the quarterly, half yearly annual returns to be filed by the deposit taking NBFCs. It is also worth being pointed out that there are also NBFCs-ND with assets size of less than Rs. 100 crore which are further classified into NBFCs-ND with asset size of Rs 50 crore and above but less than Rs. 100 crore, in respect of which monitoring is done only with respect to their assets size. The other smaller NBFCs are outside the purview of the Reserve Bank’s regulatory and supervisory ambit. It is intriguing to note that the total size of the balance sheet of NBFCs-ND-SI reached to Rs. 7,30,366 crore as at the end of March 2011, from Rs.1,70,957 crore as at the end of March 2005 growing more than four fold. It is even more interesting to note that the NBFCs-D which is a better regulated segment vis-à-vis NBFC-ND-SI makes up to just around 14 per cent of the latter. In other words, the systemically important non-deposit taking NBFCs have grown faster by nearly 7 fold as at the end of March 2011 when compared with the size of deposit taking NBFCs. As NBFC-ND-SI companies are not permitted to raise public deposits, borrowings constitute the major component of their liabilities at around 74 per cent by end of March 2005. This proportion got mellowed down to around 65 per cent by end-March 2009 reflecting subtle effect of the global crisis and the aftermath, as there was no direct impact on the Indian financial system. However, this proportion gone up to 69 per cent by end of March 2011. From the point of view of systemic interconnectedness, it is important to examine the proportion of loans and advances from the banks and financial institutions to total borrowings, accordingly it constituted 25 per cent of the total borrowings (both secured and unsecured) of NBFCs-ND-SI by end-June 2010 (Chart 5) which increased to 30 per cent by end-March 2011. These are direct borrowings in the form of loans and advances from the banks and FIs. Besides, indirectly, even assuming that major portion of the debentures, securitised debts and CPs issued by NBFCs are subscribed by the banking system, this portion alone forms another 30 to 35 per cent of the total borrowings. Thus in any case, the large chunks of resources are coming from the banking system to NBFCs. The argument therefore, is to put more checks and balances on the banking system’s exposures to NBFCs. To be precise, this is aimed to avoid any serious systemic consequences if either side of the institutions show some symptoms of trouble. To put more specific question; is there a corrective mechanism before it builds up a system level crisis. If there are any trouble among the NBFCs-ND-SI, there is a possibility to spill over to the banking system and also the mutual funds and thereby to the rest of the financial system, especially as the banks are largely based with the short term deposits, while the NBFCs, in general, are known for the medium to long term financing and high risk taking activities. Ceteris Paribus, it has the implications for mis-matches in the assets-liabilities of NBFCs, though this is subject to more detailed analysis of the maturity pattern of 18 the assets and liabilities buckets . Further, it may be cited that ‘…it is possible for an NBFC to conduct
some other non financial activity by deploying funds in non-financial assets…’ (RBI, 2011). Similar views have also been expressed by the Report of the recent Working Group on Issues and Concerns in the NBFCs Sector (Chairperson: Usha Thorat, 2011). Therefore, it calls for introspection for the regulators whether it is sufficient to fix a ceiling from the banks’ level. As a long term remedy, efforts need to be in the development of private bond market as that would serve better for diversifying the sources of funds for NBFCs.
It needs to be underlined that higher dependency of NBFCs on the banking system for their resources will not only strain banks at the time of crisis but also place NBFCs themselves into vulnerable situation. For, there are possibilities that banks can become over sensitive to a liquidity crisis or imminent crisis and they can either become too reluctant to lend to NBFCs or at the extreme case, they may completely refrain from lending to NBFCs which would further precipitate the situation, especially when NBFCs are in dire need of funds. The recent global crisis is a pointer in this direction. Further, this type of situation would compel NBFCs to turn to money market with higher costs to wade over the tight liquidity conditions impacting the money market as well. It may also be pointed out that a significant portion of their funds are also being funded by the mutual funds (RBI, 2010A). Even here similar situations are possible: NBFCs were stressed as bank loans to them had dried up and interest rates had increased in money markets, leading to higher costs of borrowing (RBI, 2010). It may be pointed out that NBFCs are also having exposures to banking system as they keep their funds in the form of fixed deposits, albeit it constitutes relatively a smaller proportion of say 11 to 12 per cent of their total assets. Even if NBFCs are not deposit taking and therefore, the question of repayment commitment of the depositors’ money does not arise, any failure of even such institutions will result in the losses that will ultimately have a cascading effect on the entire system, therefore all the institutions should come under closer scrutiny. The underlying principle to regulate these NBFCs are ‘to regulate similar risks in a similar manner’ irrespective of whether they take public deposits or otherwise. Presently, the definition of ‘systemically important’ is based only on the size of assets of NBFCs and this seems to be inadequate and highly simplistic. The size of liabilities/assets alone is not a sufficient condition for the systemic importance. This requires refinement by taking into account the intricate inter-
connectedness (both organically and financially) with the rest of the institutions within the financial system and also abroad, since intricate connectedness increases the systemic risk. For instance, a recent report from Financial Stability Board pointed out that besides the size, the degree of inter-connectedness, the degree of substitutability of the activities undertaken by the institution are to be taken into account to benchmark an institution as ‘systemically important’. The types of business activity as well as the complexity of the activity of the institutions are also necessary for redefining the ‘systemic importance’. Thomson (2009) suggested for regulatory attention to deal with the four ‘C’s (Contagion, Concentration, Correlation and Context or Condition) to identify the institutions which are systemically important. According to him, ‘contagion’ refers to failure of institution which has the potential of transmitting to other institutions/ market. ‘Concentration’ refers to the size and substitutability aspects of a particular institution in the system. ‘Correlation’ refers to (i) institution take on risks that are highly correlated with other institutions and (ii) potential for largely uncorrelated risk exposures to become highly correlated in periods of financial stress. It is also known as the ‘too many to fail’ problem. Condition/ context, of course, refer to the judgment of a particular context or situation in which an institution becomes systemically important. It also refers to the probability that economic or financial conditions if materialise that produce the state of nature where a firm becomes systemically important. Although banks and NBFCs compete for similar kinds of business on the assets side, NBFCs distinguish themselves by offering wide range of products/ services such as leasing and hire-purchase, financing of used commercial vehicles, corporate loans, investment in non-convertible debentures, IPO funding, margin funding, small ticket loans, venture capital, equity and debt investments, etc. In most of these areas either banks are reluctant to finance or finance to a very limited extent. Since the regulatory and cost-incentive structures are not identical for banks and NBFCs and that NBFCs borrow funds from banks to on-lend, it is necessary to establish adequate checks and balances to ensure that the banks’ depositors are not indirectly exposed to the risks of a different cost-incentive structure. Moreover, as NBFCs are well known to venture into the areas not permitted for the banks and in such cases, large scale exposures to NBFCs tantamount to banks entering into those areas in an indirect route. There was a substantial change in the risk perception in 1990s, world over, about the non-banking financial activities. This was one of the strong reasons for the passage of Graham Leach Bliley (GLB) Act in the US which till then separated the traditional banking from the modern day financial activities under the erstwhile Glass Steagall Act. With the passage of GLB Act, banks were permitted to pursue financial activities in the form of universal banking framework. Accordingly, the non-banking financial activities also amplified multi-fold in the US during the post GLB Act. However, the global financial crisis has proved the fact that greater risks to banks particularly came in newer forms of non-banking activities such as sponsoring of securitisation SPVs and private pools of capitals (RBI, 2011). In that context, the banking sector will be affected with growing interconnectedness with non-banking business, in case NBFCs continued to have less than par regulation and supervision with that of banks. This is not to advocate that NBFCs borrowings from banks per se will result in crisis, it is only intended to caution that excess dependency on banking sector will only exasperate if a crisis like situation arises. In view of the above, the work is also underway on structural methodologies to identify systemic importance at the IMF, the BIS and the national central banks and academia based on inputs capturing size, probabilities of failure, similarities in exposures and interconnectedness (FSB, 2011).
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